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U.S. Treasury Market David Beker Presentation prepared by Joseph Shatz and Catherina Wijaya Refer to important disclosures on page 29 Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. U.S. Treasury Market Primary market: – U.S. Treasury auctions debt to public Secondary market: – Trading through brokers/ dealers Refer to important disclosures on page 29. 2 Auction Rules Competitive Bids and Non-competitive Bids – Competitive bids specify a bid price and quantity – Maximum non-competitive bid is $5M par Single Price Auctions – All securities are allocated at the price implied by the highest accepted yield – All non-competitive bids are satisfied first – The remainder are allocated to competitive bidders starting from the ones with lowest bid yield “35%-rule” – Net long position in the auction has to be <35% of amount auctioned – at any one yield, and incl. futures, forwards, when-issued Refer to important disclosures on page 29. 3 Auction Schedule SECURITY AUCTION FREQUENCY ISSUE / SETTLEMENT DAY 4-Week Weekly (usually Tuesdays) Thursday 13-Week Weekly (usually Mondays) Thursday 26-Week Weekly (usually Mondays) Thursday 2-Year Every month End of month 3-Year Feb., May, Aug., Nov. 15th of month 5-Year Every month End of month 10-Year / Reopening Feb., May, Aug., Nov. / Mar., Jun., Sep., Dec. 15th of month 20-Year Last auctioned 1/8/86 N/A 30-Year / Reopening February / August 15th of month 5-Year / Reopening April / October Last business day of month 10-Year / Reopening Jan. & Jul. / Apr. and Oct. 15th of month 20-Year / Reopening January / July Last business day of month 30-Year Last auctioned 10/10/01 N/A Bills Notes Bonds TIPS Refer to important disclosures on page 29. 4 Auction Result Announcement Refer to important disclosures on page 29. 5 Special Types of Marketable Treasury Securities Inflation-Indexed Securities - Principal adjusts to reflect inflation STRIPS - Principal and interest components trade separately Refer to important disclosures on page 29. 6 Outstanding Public Debt: Total & Marketable Debt 9,000 8,000 7,000 Public Debt Outstanding Marketable Treasury Debt (US$ Billions) 6,000 5,000 4,000 3,000 2,000 1,000 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 Source: Bureau of the Public Debt. Note: ’06 numbers are as of March 31, 2006 Refer to important disclosures on page 29. 7 Marketable Treasury Debt Outstanding 5,000 4,500 4,000 (US$ Billions) 3,500 3,000 2,500 2,000 1,500 1,000 500 0 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 Source: Bureau of the Public Debt. Note: ’06 numbers are as of March 31, 2006 Refer to important disclosures on page 29. 8 Holdings of Marketable Debt Federal Reserve, 16% Debt Held by the Public Federal Reserve Debt Held by the Public, 84% Refer to important disclosures on page 29. 9 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 (US$ Billion) Unified Budget Deficit/Surplus 300 200 100 0 -100 -200 -300 -400 -500 Refer to important disclosures on page 29. 10 Treasury Securities Outstanding 4 3.5 2.5 Bills Notes 2 1.5 1 0.5 20 06 20 04 20 02 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 0 19 80 (US$ Trillions) 3 Source: Bureau of the Public Debt. Note: ’06 numbers are as of March 31, 2006 Refer to important disclosures on page 29. 11 Ownership of Domestically Held UST Securities 3000 $ Billions State & Local Gov 2500 Mutual Funds 2000 Insurance Companies 1500 Pension Fund State & Local Gov Pension Fund Private 1000 U.S. Saving Bonds Depository Institutions 500 Other Investors 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Refer to important disclosures on page 29. 12 Ownership of Domestically Held UST Securities (Sept 2005) Other Investors 17% Depository Institutions 7% U.S. Saving Bonds 11% Pension Fund Private 9% State & Local Gov 26% Pension Fund State & Local Gov 7% Mutual Funds 14% Refer to important disclosures on page 29. Insurance Companies 9% 13 U.S. Treasurys: Total Marketable Debt and Foreign Holdings 57% 4,500 3,500 52% Total Marketable Debt Outstanding 47% $ Billions 3,000 2,500 Foreign Holdings of Treasurys as a % of Total Marketable Debt Outstanding (RHS) 42% 2,000 37% 1,500 1,000 Foreign Holdings of US Treasurys 32% 500 0 Mar00 Sep00 Mar01 Sep01 Mar02 Sep02 Mar03 Refer to important disclosures on page 29. Sep03 Mar04 14 Sep04 Mar05 Sep05 27% Mar06 % of Total Marketable Debt Outstanding 4,000 U.S. Treasurys: Total Marketable Debt and Foreign Official Holdings 4,500 Total Marketable Debt Outstanding 31.0% 3,500 $ Billions 3,000 2,500 30.0% 29.0% Foreign Official Holdings of Treasurys as a % of Total Marketable Debt Outstanding 28.0% 2,000 27.0% 1,500 26.0% 1,000 25.0% 500 Foreign Official Holdings of US 24.0% 0 23.0% Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar02 02 02 03 03 03 03 04 04 04 04 05 05 05 05 06 Refer to important disclosures on page 29. 15 % of Total Marketable Debt Outstanding 4,000 32.0% U.S. Treasury Secondary Market 24-hours trading Electronic Trading System increasingly being used High trading volume (liquidity), Narrow bid-offer spreads (efficiency) On-the-run and Off-the-run Refer to important disclosures on page 29. 16 Primary Dealers Designated by Federal Reserve Bank of New York Bid competitively in Treasury auctions Participate in coupon passes Financing commitment to Federal Reserve Bank of New York Provide market color Merrill Lynch is one of primary dealers. Others: ABN Amro, Banc of America Securities, etc. Refer to important disclosures on page 29. 17 Inter-Dealer Brokers (IDB) Intermediaries Post aggregated bids and offers from various dealers Execute trades between dealers Provide anonymity and price transparency Two largest: ICAP PLC and Cantor Fitzgerald (60% and 28% market share, 2005)* * Source: Mizrach and Neely, 2006, http://research.stlouisfed.org/wp/2006/2006-012.pdf Refer to important disclosures on page 29. 18 Primary Dealer Transactions – U.S. Treasurys Average Daily Volume 600 500 with Inter-Dealer Brokers with Others US$ Billions 400 300 200 100 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 0 Source: Federal Reserve Bank of New York primary dealer data. Note: 2006 number is as of April 19, 2006 Refer to important disclosures on page 29. 19 Daily Trading Volume of U.S. Treasurys Note: Daily inter-dealer trading volume for the indicated on-the-run securities in billions of U.S. dollars. Sample period is Dec 30, 1996 to Mar 31, 2000. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 20 Daily Trading Frequency of U.S. Treasurys Notes: Daily number of inter-dealer trades for the indicated on-the-run securities. Sample period is Dec 30, 1996, to Mar 31, 2000. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 21 Daily Trading Frequency of U.S. Treasury Notes Notes: Mean daily number of inter-dealer trades by week for the on-the-run notes. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 22 Bid-Ask Spreads of U.S. Treasurys Notes: Mean daily inter-dealer bid-ask spreads for on-the-run securities. Sample period is Dec 30, 1996, to Mar 31, 2000. 32nds is 32nds of a point Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 23 Bid-Ask Spreads of U.S. Treasury Notes Notes: Mean inter-dealer bid-ask spreads by week for on-the-run notes. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 24 Trade Sizes of U.S. Treasury Securities Notes: Mean daily inter-dealer trade sizes for on-the-run securities in millions US$. Sample period is Dec 30, 1996, to Mar 31, 2000. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 25 Trade Sizes of U.S. Treasury Notes Notes: Mean inter-dealer trade sizes by week for on-the-run notes. Source: Michael Fleming, “Measuring Treasury Market Liquidity”, 2003 Refer to important disclosures on page 29. 26 Regulations Largely self-regulated U.S. Treasury – Set rules for issuance and sale of U.S. Treasurys – Enforcement of the rules Federal Reserve (Fed) – Market surveillance – Agent of Treasury in auctions, spot-checks customer bids Improved market transparency – GovPX in 1990 Refer to important disclosures on page 29. 27 The Role of GovPx Founded in 1990 by Primary Dealers & interdealer brokers to enhance price transparency in Treasury market 24-hour source for real-time & historic price information Available through all major market data vendors, & on the Internet Refer to important disclosures on page 29. 28 Disclosures Important Disclosures The analyst(s) responsible for covering the securities in this report receive compensation based upon, among other factors, the overall profitability of Merrill Lynch, including profits derived from investment banking revenues. ICAP PLC: The company is a corporate broking client of Merrill Lynch International in the United Kingdom. Other Important Disclosures Merrill Lynch fixed income analysts regularly interact with Merrill Lynch sales and trading desk personnel in connection with their research, including to ascertain pricing and liquidity in the fixed income markets. 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Retail sales and/or distribution of this report may be made only in states where these securities are exempt from registration or have been qualified for sale. MLPF&S usually makes a market in the bonds of this company. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk. Officers of MLPF&S or one or more of its affiliates (other than research analysts) may have a financial interest in securities of the issuer(s) or in related investments. Merrill Lynch Research policies relating to conflicts of interest are described at http://www.ml.com/media/43347.pdf. Refer to important disclosures on page 29. 29